Sep

23

One of the things that I’m finding hardest to stomach these days is the new fad of blaming the current economic crisis on those fools who dared to dream that the American Dream might include them. The accepted response to “who is most at fault for the failure of the economy?” is ‘all those people who are defaulting on their loans’. They should have been smarter. They shouldn’t have been so greedy. They shouldn’t have tried to live beyond their means. They shouldn’t just be walking away from their obligations.

Granted, now that the house of cards is collapsing, there are plenty of people eager to point fingers – at the other camp. It’s the Republican policies. It’s the Democratic Congress. It was Bill Clinton’s fault for signing the repeal of the Glass-Steagall Act. It’s the greed of the shysters and predatory lenders. But whenever the discussion comes up on various discussion boards, the one group of people that is always roundly criticized is the homeowners who bought homes based on promises that the housing market was secure, real estate always increases in value, and they’d have no problem refinancing their mortgages in a couple of years.

They should have known better, the traditional wisdom goes. How could they when the people they were supposed to trust – the Federal Reserve, Fannie Mae and Freddie Mac, their banks – were all telling them the same story? How could they when they were watching real estate values soar month after month? When the news AND entertainment media was full of stories about people buying homes and watching them double in value in just a few years? When the saner voices pointing out that this couldn’t continue indefinitely were being drowned out by hecklers – and not just any hecklers, but hecklers who were supposed to KNOW something about this business – calling them pessimists and doomsayers?

Why would anyone believe that the banks would make them a loan if the bank didn’t think they could repay it? These weren’t just loans offered by shady brokers wearing shiny polyester suits and a black hat. The lenders weren’t twirling their mustaches and snickering – at least not obviously. The most dangerous loans on offer were from major banking institutions – who would have believed that they’d be lending money that they never expected to see repaid?

But the fact is that that’s exactly what they were doing. Mortgage brokers knowingly and actively targeted people with marginal credit records, promising them to find them an “affordable” loan. The banks knowingly created loan programs that they knew were unstable and would result in huge numbers of people being unable to meet their payments. They knowingly lowered their standards of creditworthiness – and by that, I mean more than just extending loans to people who were known for not paying their bills.

I mean that they lowered the minimum income and solvency standards for loan qualification. Thirty years ago, my mother taught me that your housing costs should not exceed 25% of gross income and your total long-term debt payments should not be more than 35%. Last year, banks were making loans to people that would bring their total backend debt/income ratio to as much as 68%. That’s flat out insane – unless you’re making so much that 32% of your income is sufficient for all of your expenses besides your rent and loan payments.

And that’s just the start of the changes that drew people into going after mortgages they couldn’t afford in the long term.

Hybrid mortgages with absurdly low introductory rates were touted as a way to get into your new home along with the assurance – not quite a promise, mind you – that after two or five years of making your mortgage payments, when your mortgage payment suddenly jumped by $1000 a month you’d have built up good enough credit to qualify for a fixed-rate mortgage with a lower interest rate. It makes logical sense – five years of on-time mortgage payments equal a higher credit rating equals a lower interest rate. But there was a kicker that they forgot to mention: the fixed introductory rate was already well below the market rate so even with refinancing to a new fixed rate, those payments were going to take a huge jump.

The family home became “your biggest asset”, one to be exploited. Rather than being your security, the family home was presented as an investment that could and should be used to secure other investments.
Okay. Home equity loans have a long history. In principle, it’s not a bad thing. You borrow money from a bank and promise them that if you don’t pay it back, you’ll give them your house so they can sell it and get their money back. Here’s a kicker to the collapsing home mortgage crisis – it’s not those pesky low income first time homeowners (the ones that were supposed to benefit from Fannie and Freddie) who are losing their homes left and right. Over 60% of the homes in default are in default on secondary mortgages, aka refinances, cash-out refis and home equity loans.

The growth of “mortgage backed securities” allowed lenders to make loans to turn a quick buck, making it more attractive to hucksters – and turned the big bankers into the biggest hucksters of all.
It works kinda like this: your friend Sally needs $100. You agree to lend it to her if she’ll pay you back $5 a week for 50 weeks – which means that in the end, she’ll pay you back $250 for the $100 that she borrowed, but she has the money that she needs right now.

You then go find Joe and offer to sell him Sally’s loan payments for $175 – for $175 now, he’ll eventually collect $250. You get your money back and make $75 right now. He makes $75 in the long run. Sally gets the $100 she needs right now. This works just fine as long as Sally makes her loan payments.

Now if YOU were the one who was going to be out $100 (plus your projected profit) if she defaulted on the loan, you’d have made darn sure that she was able to pay you back that $5 a week. Under this system though, you get your money back AND a profit on it BEFORE Sally makes her payments. If she doesn’t make those payments, it doesn’t hurt you because you’ve already got your money – and you can lend it out again to someone else. At this point, it no longer hurts you financially if the person to whom you lend your money can’t pay you back. Under those conditions, it really doesn’t matter if you make risky loans because you’re not risking YOUR money at all.

Because bundling and selling mortgages was such a profitable sideline, all sorts of lenders were paying brokers to bring in loans – and paying them well. As a friend of mine noted last night, we’re talking about predatory lending practices here, folks PRED-A-TORY – do people understand what that means? That means slick-talking hucksters papering poor neighborhoods with flyers telling people about this great opportunity. This means snake-oil real estate agents promising people miracles. This means misrepresentations of government programs and door-knocking campaigns and deceptive language. This means the good old bait-and-switch – bring them in with ads for 0-down miniscule-interest loans, then sell them one that’s out of their reach.

We are all outraged when we hear about some con man bilking a sweet little old lady out of her life savings in some outrageous scheme – but when the oil-slicked con man is the US banking community in collusion with US government, our outrage is turned on the sweet little old lady. She should have known better. She should have known that the valuation of her house couldn’t possibly be that high. She should have ignored all the experts telling her that it was okay – it was better than okay – it was GOOD FOR THE ECONOMY for her to buy and buy and buy.

Banks looked the other way at ‘creative financing’ efforts by brokers and real estate agents. The loopholes and schemes that were created to exploit them were common enough knowledge that you could find out about them with a simple internet search. People were encouraged to borrow their down payments instead of saving for them. They were assisted in falsifying employment records. They were schooled in ways to artificially and temporarily ‘look good on paper’ in order to fulfill minimum requirements. One example: borrow several thousand dollars from a family member and put it in a bank account in your name to pad your assets.

Most of all, though, people believed that a bank would never lend them money if they didn’t believe it would be paid back. They trusted the banks to be looking out after their own interests – and it would obviously be against the banks’ interests to make loans that they didn’t believe would be repaid. And there was their primary sin – they trusted the experts who had already sold out their ethics in return for a quicker buck.

2 Comments so far

The problem here is that people are ignorant and should have known better that the rule of thumb on affordability or ability to pay is still the buyers yearly gross income multiplied by 3 to 3.5.

When they “relaxed” the requirement and in a highly competitive industry where one has to sell or write a loan in order for them to put food on the table the ethically challenge will naturally game the system.

Lethal deregulation combined with greed from all sides did us in on this one and there has got be accountability on those people responsible for the rut that we found ourselves.

I agree with you that there’s blame to share on all sides – and my argument is certainly not that there were NO irresponsible borrowers. There certainly were – and I’m also not arguing that there was not pressure on brokers and loan service reps to make loans or lose jobs. I personally know two former loan service reps who couldn’t stomach the business the way they were being forced to play it and quit – one to work in a grocery store and one is still not working.

Many borrowers, though, simply believed what they were told – that the current boom housing market was going to last, and they would have no trouble refinancing to the rates that they were currently paying. Thanks for your comment – it’s nice to know that someone was reading my rantings.